If you have been paying attention to trends in the automotive industry, you probably know that U.S. passenger vehicles have been getting bigger lately. Back in 2010, light trucks accounted for 50% of the new vehicles sold in the United States. But in the current model year, that figure is 68%. And for many major auto companies, trucks are even more central to their business. Last month, Ford Motor Company announced that it will phase out sales of all but two passenger car models in the coming years.
Yet, while this shift from cars to trucks has captured significant attention, another trend is gaining steam that many observers have missed. As one recent Wall Street Journal analysis explained, individual vehicle models are getting bigger. The 2018 Ford Explorer XLT is 4.9 inches longer and 5.2 inches wider than the 2008 model. Subaru introduced a new model called Ascent for the 2019-model year, which is about 5 inches longer than Toyota Highlander and has 153.5 cubic feet of space and 19 cup-holders.
The reason for this growth is the subject of some debate. The auto industry often cites “consumer demand” for larger vehicles as the key driver. They say most buyers want larger vehicles, and so they have to up-size their offerings to remain competitive.
But what if the trend is actually being driven by the very regulations designed to make our cars more efficient? The Wall Street Journal analysis points to the fact that, in 2011, the standards became “footprint based,” meaning vehicles are regulated based on the product of their length and width. Vehicles with larger footprints are subject to more moderate efficiency targets. It suggests that this feature may have incentivized automakers to super-size their cars to comply with the fuel economy regulation without actually improving fuel economy.
How can we disentangle these two possible drivers—consumers versus regulations? Before footprint-based standards were introduced in the United States, my colleague James Sallee and I decided to explore whether such size-based regulations were actually effective. After years of analysis, our results are in—and they provide important lessons for the Trump administration as it weighs how to revise fuel standards. Namely, not only are size-based standards less effective than other approaches, they are also more costly.
Let’s take a look at how we got these results.
Having started our analysis before there were size-based fuel economy regulations in the United States, we looked at Japan, which introduced similar regulations back in the 1970s, allowing us to collect decades of data. Similar to U.S. regulations, Japanese fuel economy standards are size-based (Figure 1). A minor difference is that the Japanese regulation is based on weight rather than “footprint.” Another interesting feature of the Japanese regulation is that the fuel economy target has declining “steps.”
If you look at the figure closely, you might guess that automakers have strong incentives near the edge of each step to increase car weight to move up to the next weight category, thereby reducing the fuel economy target. Using vehicle sales data, Figure 2 shows that the industry does exactly this. Automakers cluster vehicle offerings at the bottom of each step, indicating that they increased vehicle weight just enough to be able to reach the next weight category with a lower fuel economy target. We show this for two separate periods of the system.
We then looked at what happened to vehicle weights when Japan introduced a subsidy program for “eco-cars” in 2009. If a car exceeded its fuel economy target by a certain threshold, the automaker received a $1,000 subsidy per car. The threshold was again a step-wise function of car weight.
In Figure 3, we use the arrow diagram to show the “changes” in fuel economy and weight for the exactly same model between 2008 and 2012 (e.g. the Toyota Corolla 2008 model versus the Toyota Corolla 2012 model). The yellow dots show where each model was located in 2008, and the arrows show the movements of the cars that received the subsidy in 2012. The movement toward “northeast” of the diagram (red arrows) indicates that many cars had an increase in fuel economy but also an increase in weight to obtain the subsidy.
In short, our analysis shows that automakers indeed respond to the incentive created by size-based fuel economy regulation—they make bigger cars to achieve compliance at the lowest cost, often at the expense of actual gains in efficiency. The evidence makes it difficult to argue that size increases were purely in response to consumer demand for larger vehicles.
Some have argued that the U.S. system is different, because while it may be size-based, it does not feature the step-functions that are a central part of the Japanese regulations. But this is incorrect. To see why, look at the 2012 U.S. car standard in Figure 4. While the smooth function would not produce clustering at intervals, it still has exactly the same incentive structure as the Japanese system. Namely, along the declining slope of the efficiency target, automakers have incentives to increase footprints (move toward the right) instead of actually improving fuel economy (move toward the top).
What are the policy implications of our findings?
First, size-based standards distort the market, resulting in bigger vehicles. Under normal circumstances, vehicle size would be determined by consumer preferences (what size they actually want) and producer costs (how costly to make bigger cars). But, the size-based policy results in a super-sized market where buyers rarely see the optimally-sized vehicle.
Second, heavier cars come with costs to society. In the event of a traffic accident, heavier automobiles are safer for the occupants of the vehicle (this is a private benefit) but more dangerous for pedestrians or the occupants of other vehicles (economists call this an “externality”). Michael Anderson and Max Auffhammer quantify the dollar value of this negative externality. Combining their estimate and our finding, we show that the social cost from this safety externality by itself is substantial ($1 billion per year for the Japanese automobile market).
Then, how can we improve the policy design? In our article, we emphasize that there is a simple solution: a flat standard (i.e. a fuel economy standard that does not depend on car size) with compliance trading, by which those who achieve the standard can sell credits to those who do not. Such a system would allow the auto industry to achieve compliance at the lowest cost. In the context of the Japanese car market, we show that the flat standard with compliance trading would achieve the government’s efficiency goal at less than half of the compliance cost of the size-based regulation. While U.S. fuel standards have some form of trading in place, my colleague Sam Ori noted in an earlier Forbes post that the system could be vastly improved.
There are, of course, other potential reasons governments pursue size-based regulations, including political reasons to favor the producers and consumers of larger vehicles. However, our empirical evidence suggests that policymakers should think carefully about whether these potential benefits really exceed the cost of size-based fuel-economy regulations.
For another idea on how to restructure fuel standards to make them more efficient, particularly in the presence of uncertainty in gasoline prices, read about my colleague Ryan Kellogg’s newly published paper here.